Saturday, July 24, 2010

Bottom of the pyramid employees

In businesses that are bottom heavy (ignore the pun) like retail, transportation and warehousing, there is usually a significant difference of salary between the top and the bottom. The CEO of a retailing firm could have a salary package that is 200 to 400 times more than the package of a worker who manages the cash register. Such businesses are also characterised by high attrition of low salary scale employees and also have lower training expenses.

That lower rung employees will have an attrition of around 15% per month is assumed to be a unchangeable fact. Firms design all their processes around this fact. These businesses try to "McDonaldise" their shop floor processes and reduce the dependence of employee knowledge on business. Employees are specialised in a particular task and department. So, a cash counter person will do just that. A person in the toys section will do just that. They set up a tall hierarchy based structure to ensure process compliance. They have a strong recruitment division and also they foster partnerships with recruitment consultants. The salary of the lower rung workers is kept at a minimum and they are trained only if they stay with the company for more than a year. It seems logical. If they are going to leave, it does not seem sensible to waste resources on these employees.

A retail firm in Spain has turned this logic on its head. They pay their shop floor level employees higher, and invest significantly more in their training. Mercadona, a Spanish retailer, has sales per employee that is 18 times the average for Spain and 50 times higher than the USA. They have an attrition rate of only 3.5% per year. Look at the article here -

Its the vexing issue of questioning the assumptions. Bottom of the pyramid employees are directly in contact with the customers. Customers need intelligent employees. A McDonald's with 15 items only on the menu can standardise every little thing. A super market with 1500 items cannot do this. Many times sale happens because of good selling by the employees. And employees become good at selling only if they are on the job for some time and they feel good about the job that they are doing.

Another way to look at it is the cost issue. A store clerk would have a salary or around Rs. 45,000 per year only. A retail CEO can have a salary of around Rs. 20 million. Assuming a store has 400 ground level staff, their total package would still less the package of the single CEO. A 20 % increment amounts to Rs. 750 per employee per month. In an apparels store if one employee sells one extra shirt, this cost is easily recovered. It may not be as simple as this. A salary hike for the shop floor workers would have a domino affect increase for the supervisors and above also. Yet, the impact would not be a difference of life and death for the organisation.

If it has been done in Spain, I am sure it can be done in India also. But, someone needs to challenge the basic assumption. Some firm needs to start at recognising that the bottom of the pyramid employees are important. They need to move from lip service to actually facilitating these employees. Sam Walton had said, "I take care of my employees, they in turn take care of my customers". Someone needs to actually put this into practice.

Tuesday, July 13, 2010

Growth through capacity

A decade back idle capacity was abhorred. It was the duty of the plant manager to ensure that everyone was kept busy and the machines kept churning out material. High utilisation was a rule to balance the high costs of capacity. This also led to large batch sizes and long product runs. This was the time when demand was relatively stable, competition was manageable, retailers had low bargaining power and organisations were sure that sooner or later they would sell everything that they produce.

The ripples caused by the recession and the subsequent recovery have ensured a high variance in demand. There is a steady increase in the product variety being offered. Competing players are also coming out with new products and innovative promotions. Retailers are also more adamant on the exact type of products they need. Organised retailers can in fact bully manufacturers and brand owners in product assortment and dispatch frequency. Given this scenario, now the companies are laden with many products that they are not able to sell.

In the first scenario, the only cost of inventory was the cost of interest for the amount carried. This was a minor cost. If the cost of working capital was 12% (assumed for simplicity sake) and a product stayed in the factory warehouse for a month, the carrying cost would be only 1%. The product margin more than made up for this cost. Now, with the risk of the product not getting sold at all this inventory holding cost has shot up.

Directly reducing inventory would reduce customer service. Especially with a higher variety and fluctuating demand, low inventory would lead to low fill rates. This would lead to high costs of not lost customers. Factories operating at high utilisation would have inflexible and rigid production schedules. A change of customer requirement is usually met through inventory. With low inventories, a change would have to be met with a change of production schedules. Again, with low inventories, A change of production schedule will invariably cause a stock out of some other product B.

Demand variability is very difficult to control. So, it seems inevitable that companies learn to live with high inventories and high wastage. They can of course try to squeeze costs from vendors and other service providers. This is precisely what companies are indulging in now. What the companies need to do at this stage is to re look at the way they 'cost' capacity.

Look at this article here:
The largest consumer goods company in India, HUL is planning to combat the volatility with capacity expansion. They are planning an increase in the capacity levels and a few places like the Selvas plant has doubled their existing assembly lines.

Excess capacity is definitely cost. But here again, like the inventory of the earlier era, machines are sooner or later likely to be used. Having spare capacity means that the manufacturer is more flexible. They can be more responsive to the existing market demand and give the customers exactly what they want. Making consumer goods is not like making rockets. The lead time to make a product is a few hours provided the capacity exists. Thus firms can drastically cut inventories if they have spare capacity.

Yes, the machines would be idle and the operators would also not have anything to do once in a while. But, overall the total costs would reduce and the fill rates would go up. Cheers to HUL for this change. Now with the leader showing the way, may be the others will follow.

Monday, July 5, 2010

Profits from expansion

The hypermarket chain Hypercity has 7 stores in India currently - three in and around Mumbai and 4 in other cities. Shoppers Stop had a 19% equity in the store which they have increased to 51%. Now they want to open eight new stores by next year and expect to triple their revenues to 1000 crores (from current 330 crores) by FY2012. The statement from the group says that this will lead the groups to break even in the FY2012. The detailed article is here:

Let me bet....I do not see Hypercity breaking even in FY2012. Hypercity will of course have new and creative reasons in 2012. Unless something radical happens, I am sure that I will win my bet. Let me explain.

Expansion helps improve the profits if it leads to better utilisation of existing resources. If a retailer has 5 stores in a city, starting say 3 more could help. The supply chain infrastructure would be more or less the same. The same overheads (city office infrastructure and professionals, buying team, etc) that earlier took care of 5 shops would now take care of 8 shops. The only new cost in opening the 3 stores would be the cost of employees in the store. So, there is a good chance of increasing the net profit for the retailer.

For Hypercity, each location is a large store and has a baggage of huge overhead attached to it. Every individual Hypercity store would have to replicate all these expenses. There would be very little central overhead that would be shared. As mentioned in the article, 60% of the store's sales are foods. Since the food preference is regional in nature the merchandising and the buying team would have to be different for every region, or for that matter every store. Since every store would be in a different city, new supply chain infrastructure would have to be set up.
So, assuming that they follow the same policy, it is difficult to imagine Hypercity making profits with expansion.

McDonald's in India had a model where they limited themselves to around 30 stores in a few pockets for 4 years. They made all the stores profitable, mapped the necessary processes, created the support infrastructure and then had a full blast expansion. McDonald's was a proven global brand. They had most of the processes available and could have implemented the same in India. Their India people were smart and they instead expanded slowly.

At Rs. 330 crores from 7 stores, the current revenue comes to an average of Rs. 45 crores per store. In 2012, when the news release expects Hypercity to break even, the 8 new stores would only be one year old. It would be reasonable (or optimistic) to assume that each of these 7 new stores would also have a revenue of around Rs. 45 crores in 2012. This totals up to Rs. 360 crores. The existing 7 stores would have to get Rs. 640 crores and this comes to more than Rs. 90 crores per store. What we are talking of here is a 100% jump in revenue in just two years. Surprisingly the news release mentions that the strategy would be the same. I am not sure if it is wise to expect the same strategy to yield such amazing hyper growth for Hypercity.

Expansions help improve profits if the basic model is correct. Else the expansion could merely be postponement of the inevitable failure. To use expansion as a way out of losses is a tried and tested methodology and it has almost always led to failure. Somehow business professionals have a scant respect for history and they forget that history repeats itself.